OPEC and Its Goals, Members, and History

What Are Its Top Three Goals?

The Organization of Petroleum Exporting Countries is an organization of 14 oil-producing countries. It controls 61 percent of the world's oil exports and holds 80 percent of the world's proven oil reserves. OPEC's decisions have a significant impact on future oil prices.

The Oil and Energy Ministers from the OPEC members meet at least twice a year to coordinate their oil production policies. Each member country abides by an honor system in which everyone agrees to produce a certain amount.

If a nation winds up producing more, there is no sanction or penalty. Each country is responsible for reporting its own production. In this scenario, there is room for "cheating." A country won't go too far over its quota though unless it wants to risk being kicked out of OPEC.

Despite its power, OPEC cannot completely control the price of oil. In some countries, additional taxes are imposed on gasoline and other oil-based end products to promote conservation. Oil prices are also set by the oil futures market. Much of the oil price is determined by commodities traders. That's the underlying reason why oil prices are so high.

Starting January 2017, it will produce 32.5 million barrels per day. That's still above its average 2015 level of 32.32 mbpd. The agreement exempted Nigeria and Libya. It gave Iraq its first quotas since the 1990s. Russia, not an OPEC member, voluntarily agreed to cut production.

The cut came a year after OPEC had raised its production quota to 31.5 mbpd on December 4, 2015. OPEC was struggling to maintain market share. Its share fell from 44.5 percent in 2012 to 41.8 percent in 2014. Its share fell because of a 16 percent increase in U.S. shale oil production. As the oil supply rose, prices fell from $108.54 in April 2012 to $34.72 in December 2015. That was one of the biggest drops in oil price history.

OPEC waited to cut oil production because it didn't want to see its market share drop further. It produces oil more cheaply than its U.S. competition. The cartel toughed it out until many of the shale companies went bankrupt. That created a boom and bust in shale oil.

OPEC's Three Goals

OPEC's first goal is to keep prices stable. It wants to make sure its members get a reasonable price for their oil. Since oil is a somewhat uniform commodity, most consumers base their buying decisions on nothing other than price.

What's the right price? OPEC has traditionally said it was between $70 and $80 per barrel. At those prices, OPEC countries have enough oil to last 113 years. If prices drop below that target, OPEC members agree to restrict supply to push prices higher.

Saudi Arabia needs $70 a barrel to break even. That price includes exploration and administrative costs. Saudi Arabia's flagship oil company, Aramco, can pump the oil at $2 to $20 a barrel. Saudi Arabia has cash reserves to allow it to operate at lower prices. But it is a hardship the country would prefer to avoid.

Without OPEC, individual oil-exporting countries would pump as much as possible to maximize national revenue.

By competing with each other, they would drive prices even lower. That would stimulate even more global demand. OPEC countries would run out of their most precious resource that much faster. Instead, OPEC members agree to produce only enough to keep the price high for all members.

When prices are higher than $80 a barrel, other countries have the incentive to drill more expensive oil fields. Sure enough, once oil prices got closer to $100 a barrel, it became cost-effective for Canada to explore its shale oil fields. U.S. companies used fracking to open up the Bakken oil fields for production. As a result, non-OPEC supply increased.

OPEC's second goal is to reduce oil price volatility. For maximum efficiency, oil extraction must run 24 hours a day, seven days a week. Closing facilities could physically damage oil installations and even the fields themselves. Ocean drilling is difficult and expensive to shut down. It is then in OPEC's best interests to keep world prices stable. A slight modification in production is often enough to restore price stability.

For example, in June 2008, oil prices hit an all-time high of $143 per barrel. OPEC responded by agreeing to produce a little more oil. This move brought prices down. But the global financial crisis sent oil prices plummeting to $33.73 per barrel in December. OPEC responded by reducing the supply. Its move helped prices to again stabilize.

OPEC's third goal is to adjust the world's oil supply in response to shortages. For example, it replaced the oil lost during the Gulf Crisis in 1990. Several million barrels of oil per day were cut off when Saddam Hussein's armies destroyed refineries in Kuwait. OPEC also increased production in 2011 during the crisis in Libya.

OPEC Members

OPEC has 13 active members. Saudi Arabia is by far the largest producer, contributing almost one-third of total OPEC oil production. It is the only member that produces enough on its own materially impact the world's supply. For this reason, it has more authority and influence than other countries.

Indonesia joined in 1962 but left in 2009. It rejoined in January 2016 but left after the OPEC conference in November 2016. It did not want to cut oil production.

History

In 1960, five OPEC countries allied to regulate the supply and price of oil. These countries realized they had a nonrenewable resource. If they competed with each other, the price of oil would drop too far. They would run out of the finite commodity sooner than they would if oil prices were higher.

OPEC held its first meeting on September 10-14, 1960, in Baghdad, Iraq. The five founding members were Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. OPEC registered with the United Nations on November 6, 1962.

Non-OPEC Oil-Producing Countries

Many non-OPEC members also voluntarily adjust their oil production in response to OPEC's decisions. In the 1990s, they increased production to take advantage of OPEC's restraints. That resulted in low oil prices and profits for everyone. These cooperating non-OPEC members are Mexico, Norway, Oman, and Russia.

Oil shale producers did not learn that lesson. They kept pumping oil, sending prices plummeting in 2014. As a result, many went below their break-even price of $65 a barrel. OPEC did not step in to lower its production. Instead, it allowed prices to fall to maintain its own market share. The break-even price is much lower for most of its members. But U.S. producers got more efficient.

If approved in April 2019, the three-year alliance would set production levels among all 23 members. OPEC would continue its regular meetings but the Russia-led group would also attend. Iran would prefer that the two groups only meet when there is a crisis.